Question 1

A property is financed with a 75% loan at 11.5% over 25 years.The property produces an ATIRR on total investment of 7.34% based on a tax rate of 31%.What can be said about the leverage associated with the property?
A)Negative leverage exists
B)Positive leverage exits
C)No leverage exists
D)Can't tell without knowing the ATIRR on equity

Accepted Answer

Negative leverage exists because the cost of borrowing (11.5%) is higher than the return on the total investment (ATIRR of 7.34%).

Question 2

Which of the following typically would NOT be used as a basis for a participation loan?
A)Increase in value over the holding period
B)NOI in excess of a base amount
C)Cash Flow after regular debt service
D)Potential gross income

Accepted Answer

Potential gross income is commonly used as a basis for a participation loan, as it represents the maximum possible income that the property can generate. The other options (increase in value over the holding period, NOI in excess of a base amount, and cash flow after regular debt service) are all commonly used as bases for participation loans.

Question 3

Which of the following gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time?
A)Convertible loan
B)Sale-leaseback
C)Accrual loan
D)Interest only loan

Accepted Answer

A convertible loan gives the lender the option to convert the loan into an equity stake or purchase a full or partial interest in the property at the end of the loan period. It allows the lender to participate in the potential appreciation of the property value over time.

Question 4

A loan in which the lender has an option to purchase an equity interest in a property is known as a(n):
A)Participation loan
B)Accrual loan
C)Convertible loan
D)Percentage loan

Accepted Answer

A convertible loan is a type of loan where the lender has the option to convert the loan into an equity interest in the property.

Question 5

Which of the following is FALSE regarding negative amortization?
A)It can result in a decrease to the borrower's equity in the property
B)It usually increases default risk
C)It usually has a lower interest rate than a conventional loan
D)It usually results in a lower DCR

Accepted Answer

Negative amortization loans typically have a higher interest rate than conventional loans, as they pose a higher risk to the lender. A lower interest rate would make the loan more attractive to borrowers, but it would also increase the risk to the lender. A lower debt service coverage ratio (DCR) may occur with negative amortization loans because the monthly payment does not cover the full interest owed, leading to a lower cash flow to cover operating expenses. Negative amortization can result in a decrease to the borrower's equity in the property because the unpaid interest is added to the loan balance, increasing the overall amount owed. Negative amortization is also associated with an increased risk of default because the borrower is not paying down the principal balance of the loan.

Question 6

Which of the following would NOT be considered an advantage that an investor might consider under a sale-leaseback of land?
A)The sale-leaseback in effect provides 100% financing on the land
B)Lease payments are tax deductible
C)The sale-leaseback provides the same depreciation deductibility with a smaller equity investment
D)The land may appreciate over the holding period

Accepted Answer

The appreciation of the land is not an advantage that would be considered under a sale-leaseback as it is not directly related to the transaction. The other three choices are all potential advantages of a sale-leaseback.

Question 7

Lenders for income-producing properties refer to loans that are short term and require little or no amortization as:
A)Missile loans
B)Straight loans
C)ARM loans
D)Bullet loans

Accepted Answer

Bullet loans refer to loans that have a short term with little or no amortization, and are often used for income-producing properties. This type of loan requires a large payment at the end of the term, which is why it is called a bullet loan.

Question 8

All other things being equal,which of the following best describes the effects of leverage on an investment's risk-return characteristics (assuming the expected return is greater than the lending rate)?
A)Lower expected return,lower risk
B)Lower expected return,higher risk
C)Higher average return,higher risk
D)Higher average return,lower risk
E)Risk-return characteristics have no role in investment decision making

Accepted Answer

Leverage amplifies both potential returns and potential risks because it involves borrowing money to invest, aiming to earn more than the cost of borrowing. If the expected return is greater than the lending rate, leverage can lead to a higher average return but also increases the risk, as both gains and losses are magnified.

Question 9

A lender requires a 1.20 debt coverage ratio as a minimum.If the net operating income of a property is $45,000,what annual amount of debt service would provide the required debt coverage ratio?
A)$37,500 or higher
B)$37,500 or lower
C)$54,000 or higher
D)$54,000 or lower

Accepted Answer

To calculate the annual debt service required for a 1.20 debt coverage ratio, we divide the net operating income by 1.20.

Annual Debt Service = Net Operating Income / Debt Coverage Ratio 
Annual Debt Service = $45,000 / 1.20 
Annual Debt Service = $37,500

Therefore, the answer is B) $37,500 or lower, as any amount higher than $37,500 would result in a debt coverage ratio higher than 1.20.

Question 10

If properly constructed,and assuming everything but the structure of the interest payment is equal,which of the following loans would typically have the highest first-year debt service?
A)Accrual loan
B)Conventional loan
C)Interest only loan
D)Participation loan

Accepted Answer

Conventional loans typically have the highest first-year debt service because they include both principal and interest payments from the start, unlike interest-only loans which only require interest payments initially, or accrual loans where interest might be added to the principal. Participation loans' payments can vary based on the agreement but don't inherently have the highest first-year debt service.

Question 11

A property produces an 8.92% ATIRR on the total investment considering a tax rate of 28%.What is the maximum interest rate that could be paid on debt without causing the leverage to be negative?
A)12.39%
B)11.42%
C)6.42%
D)9.37%

Accepted Answer

The maximum interest rate that could be paid on debt without causing the leverage to be negative is the same as the after-tax internal rate of return (ATIRR) on the total investment, which is 8.92%. This means that as long as the cost of debt is less than or equal to the ATIRR, leverage will not be negative. However, the question asks for the maximum interest rate, which implies looking for the highest rate that does not exceed the profitability of the investment. Given the options, 12.39% is incorrectly marked as correct due to a misunderstanding of the concept. The correct interpretation should be that none of the provided options correctly match the ATIRR of 8.92%, and the premise of my explanation was based on a misunderstanding of how leverage and ATIRR interact. The correct approach involves calculating the break-even cost of debt based on the ATIRR, but without the specific formula or additional data provided in the question, the direct application of the ATIRR as the maximum interest rate for debt is incorrect.

Question 12

A loan in which the lender receives a percentage of the net operating income from the property is known as a(n):
A)Participation loan
B)Accrual loan
C)Convertible loan
D)Percentage loan

Accepted Answer

In a participation loan, the lender participates in the profits of the project, usually by receiving a percentage of the net operating income from the property. This type of loan is often used in commercial real estate financing and is different from a conventional loan, where the lender only receives interest and principal payments. The other options (B, C, D) are not used to describe loans that involve sharing profits or income with the lender.

Question 13

The maximum interest rate that could be paid on a debt before the leverage becomes unfavorable is referred to as the:
A)Incremental cost of debt
B)Break-even interest rate
C)Favorable interest rate
D)Optimistic interest rate

Accepted Answer

The break-even interest rate is the maximum interest rate that a company can afford to pay on a debt before the leverage becomes unfavorable. Beyond this rate, the cost of borrowing becomes too high, and the company's profits will start to decrease instead of increasing. Therefore, B is the correct choice.

Question 14

Which of the following is FALSE regarding interest only loans?
A)They usually have balloon payments
B)They have greater amortization than conventional loans
C)They may result in more cash flow to the investor
D)They may allow for a lower DCR

Accepted Answer

Interest only loans have lower or no amortization, which means the borrower only pays the interest on the loan, and not the principal. This results in lower monthly payments but also means that the principal balance doesn't decrease over time. Therefore, statement B is false as interest only loans have lower amortization than conventional loans.

Question 15

A property is financed with an 85% loan-to-value ratio at 10% interest over 25 years.What would the BTIRR_E on equity be estimated at,given that the BTIRR_p is 10.75%? A)10.1% B)10.4% C)15.0% D)13.2%

Accepted Answer

The BTIRR on equity (BTIRR_E) is generally higher than the BTIRR on the property (BTIRR_p) due to the leverage effect. Given the high loan-to-value ratio and the BTIRR_p of 10.75%, the BTIRR_E would be significantly higher, making 15.0% a reasonable estimate.

Question 16

Which of the following is NOT a benefit of a sale-leaseback of land for investors?
A)It is a way of effectively obtaining 100% financing
B)The lease payments are tax deductible
C)Land cannot be depreciated for tax purposes
D)The land value may increase over the holding period

Accepted Answer

A sale-leaseback allows the seller to obtain financing by selling the asset and leasing it back, making lease payments tax deductible. However, the potential increase in land value is a benefit of ownership, not a sale-leaseback.

Question 17

Which of the following is also referred to as a negative amortization loan?
A)Participation loan
B)Accrual loan
C)Convertible loan
D)Interest only loan

Accepted Answer

A negative amortization loan is one where the payments made by the borrower are less than the interest charge on the loan. This causes the loan balance to increase rather than decrease over time. "Accrual loan" is another term used for this type of loan, as the interest that isn't covered by the payments accrues and is added to the principal balance.

Quiz 12: Financial Leverage and Financing Alternatives

A property is financed with a 75% loan at 11.5% over 25 years.The property produces an ATIRR on total investment of 7.34% based on a tax rate of 31%.What can be said about the leverage associated with the property?

Which of the following typically would NOT be used as a basis for a participation loan?

Which of the following gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time?

A loan in which the lender has an option to purchase an equity interest in a property is known as a(n) :

Which of the following is FALSE regarding negative amortization?

Which of the following would NOT be considered an advantage that an investor might consider under a sale-leaseback of land?

Lenders for income-producing properties refer to loans that are short term and require little or no amortization as:

All other things being equal,which of the following best describes the effects of leverage on an investment's risk-return characteristics (assuming the expected return is greater than the lending rate) ?

A lender requires a 1.20 debt coverage ratio as a minimum.If the net operating income of a property is $45,000,what annual amount of debt service would provide the required debt coverage ratio?

If properly constructed,and assuming everything but the structure of the interest payment is equal,which of the following loans would typically have the highest first-year debt service?

A property produces an 8.92% ATIRR on the total investment considering a tax rate of 28%.What is the maximum interest rate that could be paid on debt without causing the leverage to be negative?

A loan in which the lender receives a percentage of the net operating income from the property is known as a(n) :

The maximum interest rate that could be paid on a debt before the leverage becomes unfavorable is referred to as the:

Which of the following is FALSE regarding interest only loans?

A property is financed with an 85% loan-to-value ratio at 10% interest over 25 years.What would the BTIRR_E on equity be estimated at,given that the BTIRR_p is 10.75%?

Which of the following is NOT a benefit of a sale-leaseback of land for investors?

Which of the following is also referred to as a negative amortization loan?